"The market disruptions of 2008 were extremely costly to dealers and investors. These costs would have risen to catastrophic levels had the government not provided direct or indirect aid." -- Citadel Group paper on central counterparty clearing
Ken Griffin, CEO of the asset management behemoth Citadel, pulled no punches in a speech Friday to regulators and industry leaders at an all-day symposium on OTC derivatives clearing held at the Chicago Federal Reserve Bank.
"Reform of our OTC derivatives markets is one of the most important transformations of the capital markets we will see in our lifetime," he told an audience made up of international regulators, bankers, brokers and exchanges. In his luncheon address, he spoke about the new Dodd-Frank legislation and the industry’s obligation to work with the regulators.
"We must all appreciate that until this law is implemented, the conditions that gave rise to the 2008 crisis have not changed," he said.
The reforms that would push the capital markets forward were "central clearing of the broadest possible product set, across a broad range of over-the-counter derivative asset classes; objective, risk-based governance frameworks; risk-based capital charges that ensure appropriate reserves and eliminate externalities; and transparency," he said.
Griffin noted Citadel was a huge proponent of central clearing. He cited all the pluses futures exchanges have provided the markets for years, adding that he has personally seen the difference between the OTC world and futures clearing style. When energy hedge fund Amaranth went bust and J.P. Morgan and Citadel put together a deal to take over the funds, he noted the unwinding of the futures positions was "flawless" but the OTC side had staff keying in 15,000 confirms. He added that with Lehman’s fall, the futures positions were completed in a morning whereas the OTC positions "are still being unwound today." He said it was "a complete disaster."
He noted the failure by the government and industry to follow up on recommendations made by the President’s Working Group after the Long-Term Capital Management near-collapse in 1998 was a lost opportunity to prevent the current financial crisis.
He had no sympathy for dealers who are fighting the regulatory changes. "The OCC reports that in the U.S., only five dealers are on one side of 96% of all derivatives transactions." He pointed out in a New York Times article, it was estimated profits of derivatives trading was close to $60 billion. "Certainly worth protecting," he said. "But today’s status quo is simply unacceptable.".
He pooh poohed the arguments from regulatory nay-sayers stating that "it should be clear that the failure of market discipline and regulation that led to the 2008 crisis caused huge costs in diminished growth to the economy and jobs. Need I say more than AIG?"
He noted by taking action to "largely eliminate the externalities created by today’s tangled web of bilateral derivatives" the industry can reduce the risk of both "too big" and "too interconnected" to fail, bring transparency to the market and increase confidence in the markets. Certainly it will "change the business practices of all market participants" but will help market players to "efficiently manage their balance sheets," he said.
He called for the industry to work with regulators to "get this right."